Speculations on the speculator spectacle

Is the speculator-fueled mini-boom cause for celebration – or concern?

Flipping out

Tracing back the roots of our Great Recession, speculators and mortgage lenders were revealed to be responsible for the vast amount of foreclosures that triggered the financial crisis and led to the Lesser Depression.

Between 2003 and 2006, rampant speculation amounted to over 25% of all sales in California. Flippers, riding on the back of market momentum, quickly churned titles to houses to make a quick buck, cashing-in on the financial accelerator effect driven by Wall Street mortgage money funds.

Speculation, on top of irresponsible mortgage lending, directly contributed to a surplus of vacant, unsold homes – around 500,000 both new and used – as we headed into the serious downturn of 2007. The Great Recession of 2008 brought demand for home ownership to a temporary halt, further pushing California prices and sales volume into a downward spiral from which we’re just now beginning to recover.

Speculators to the rescue – or revenge of the bubble?

Housing data from earlier this year looked optimistic in sales volume and pricing reports. Home prices rose slowly while delinquencies and foreclosures moved downward between mid-2011 and mid-2012. Of concern to supply-siders, the inventory of unsold homes sitting on the market has dwindled greatly in 2012. Essentially, California’s scab appears to be healing.

These are positive indicators — but what was the cause of the early 2012 rise in sales, and is it sustainable or just another bounce along the bumpy plateau recovery we have been saddling for the past five years? Further, just who is soaking up all this excess inventory?

In December 2010, absentee buyers – those who do not occupy the property purchased – acquired 22.7% of all homes sold in Southern California (So Cal) and 18.7% of homes sold in Northern California (Nor Cal), according to DataQuick.

For annual comparison, by December 2011, absentee buyers accounted for 26.4% of the sales in So Cal and 23.8% in Nor Cal. In July 2012, absentee buyers constituted 27% of purchases in So Cal and 23% in Nor Cal.

Witness the 16% jump in So Cal and 27% jump in Nor Cal absentee buyers – primarily the product of speculation.

Likewise, all cash-buyers in December 2010 accounted for 27.2% of home purchases in So Cal and 24.3% in Nor Cal. One year later, cash-buyers comprised 29% of home sales in So Cal and 27.4% in Nor Cal. In July 2012, cash-buyers jumped up to 31% in So Cal and stayed at 27.3% in Nor Cal.

So, will these speculators rescue the housing market, or is the bubble starting to inflate all over again?

Those who have money will chase the deals

Speculator optimism is self-perpetuated; think of a hunter stalking his own set of tracks as he circles, lost in the woods. It’s a reverse matrix of acquisition for success, and a formula for failure in most all enterprises. It is speculative investing for profit necessitated on a prompt resale.

Worse, speculation-on-speculation has been taking place as ever more-moneyed syndicators (read: Wall Street money types) are buying up properties acquired by less-moneyed syndicators (local poolers of funds) who preceded them. All the while, these properties have yet to be resold to buyer-occupants who will remove the properties from the MLS inventory for any considerable amount of time.

Bubbles are drummed to the same beat as the syndicated investment staple: the good ol’ ponzipyramid scheme. As speculators using other people’s money (OPM) sell to other speculators with their pockets full of OPM, they keep a significant supply of vacant unused homes in their own inventories to turn deeds into profit on a flip. The player who started the game, gets out first and rakes in the most green. The last out lose out.

The programs they espouse run in two varieties: an immediate flip of a short sale property, or a temporary lease to an interim tenant until the market moves up 20% to 30% so the speculator can promptly sell and profit. The unwelcome grab ‘em and bag ‘em deal-hunters graft themselves onto the housing vine, feeding their market convictions in a frenzy of speculator imposed pricing.

Houses where nobody lives

In this current artificial market, speculators are the top buyers.

In this current artificial market, speculators are the top buyers, but their profit generating success relies on the separate ability to sell, not buy.

Buying with cash is the easy part: it takes little talent, minimal effort and no luck, just cash reserves. Without the demand that naturally occurs when real end-userbuyer-occupants step into the game, the uptick in the market will inevitably lose momentum and tumble. Just as an apple freed from a tree will fall, financial gravity will pull these prices right back down.

As sales data now stand, the MLS environment is stuck with a lopsided equation missing the crucial variable: buyer demand. Supply-side inventory issues are just a networking distraction as they only affect pricing.

Though speculators may be snapping up houses, this sort of activity is just a prolonged game of musical chairs, a negative indicator of the real estate market’s health. The litmus test for long-lasting housing demand stems from organicgrowth: a strong, continual influx of end-userbuyers – the single best remedy for the ailing housing market.

Speculators are not users by any definition. Their practice is to sandwich themselves into property ownership solely to extract money from the market (not a home sold to a buyer who places his prior home on the market, or a builder), while putting in as little an investment as possible.

Thus, this “sellers-once-removed” brand of speculators will not likely be able to pull their profits in the next couple of years.

Also, the illusion of genuine market growth will be gone as the sales numbers of the past several months of 2012 reflect shallow activity – not unlike the 2009 first-time homebuyer tax-credit stimulus.

When speculators are done running their course (which may already be underway), the increased home prices and decreased supply they alone brought on will go with them, probably ending in late 2013. From this new vantage point, agents will begin seeking out the real buyers without speculator distraction as the now customary short sales, foreclosures and REOs uptick for the next three or four years.

The thought is tempting: the more hands a house goes through, the more fees an agent collects, unless he has chosen to be paid on the flip.

Every time a house is flipped, the price artificially inflates, fueling a bubble.

But in the long haul, every time a house is successfully flipped, the price artificially inflates, fueling a bubble that will burst with no immediate buyer-occupants to clean up the mess. Of course, lenders will blame overreaching appraisers and buyers. The chaos will again attract speculators to cash-out those that need to dump the property now.

Buyer-occupants will evaporate from the market, deterred by today’s artificial asset price inflation. Speculators will dump their acquisitions once they realize there is no demand from which they can glean profits.

Most critically, agents will be the ones left holding the over-inflated bag.

So, will speculators save this market and the real estate agents dependent upon it?

4 Comments

jose
on September 18, 2012 at 9:52 am

The tide will continue to rise into the upper middle class so that 300k earners in 20 years will live how 40k earners live now. Only then will there be sufficient discontent amongst the educated that denial of a decline can no longer be ignored. Then there will once again be a shot heard around the world. All of this has happened before, and it will happen again.

I agree with Paul and Kim, as long as investors buy these properties for rental use and hold it for the long run, it is a positive! Since nobody can buy these non-owner properties any longer for no money down, I am confident that most of these buyers are investors and not speculators!

I agree with Paul above. I think this article does the classic thing of making a general statement way too general. Agents on the street see development by development in their markets. Buyers specific to those developments ARE buying to live in, for vacation or investment properties, or for rentals. They are not looking to flip..are in fact very ok with holding for 10 years or so. Our bottom price/sf here in the Palm Springs Valley has bottomed out at a price/sf that can be attained with a low-paying job. That is where it has stayed.

While I agree that investors have had, and will continue to have, a signficant impact on the market here in California, I cannot agree with a great deal of what is said here. The largest and best capitalized investor groups are buying and holding properties for the long term. They have attracted capital because they can offer attractive yields on their rental portfolios in an environment where other fixed rate investments offer extremely low returns. At the same time there is a steadily emerging demand for ownership, particularly at the lower end of the market. The problem is that these potential owners are losing out to these well-funded investor groups. I do not consider the multiple offers that we see consistently on the homes we place on the market–exclusively to potential homeowners–as a temporary phenomenon, or symptomatic of a bubble. They indicate to me that there is, and will continue to be, a very strong demand for ownership, particularly since at these prices and at these interest rates, the cost of ownership can be less than the cost of renting.